In 1881, Detroit’s Brush Park neighborhood was called “Little Paris,” a nickname that faded long before this streetscape was photographed again in 2011. The cover of this annual report shows the same neighborhood in the foreground but not the same house that appears below. Photos: top ©Burton Historical Collection, Detroit Public Library; bottom ©Michael G. Smith 4 Federal Reserve Bank of Richmond l 2016 ANNUAL REPORT Understanding Urban Decline By Santiago Pinto and Tim Sablik ver the past two centuries, the population of the United States has become increas- ingly concentrated in cities. In the 1800s, only 6 percent of people lived in urban areas. Today, nearly two-thirds of Americans live in cities, and these cities account O 1 for only 3.5 percent of available land in the country. Urbanization also is taking place around the globe. More than half of the world’s population lives in cities today, and the World Bank estimates that cities collectively will add another two billion people by 2045. Not only is population in the United States concentrated in cities, the nation’s economic activity is as well. Large cities accounted for roughly 85 percent of the country’s gross domes- tic product (GDP) in 2010.2 Concentrating economic activity in this way produces a number of benefits. Places with higher population density exhibit faster growth in productivity and per-capita GDP. Cities are also wellsprings of innovation, accounting for a disproportionate share of new patents.3 Clearly, cities matter. These benefits make it all the more puzzling that a number of prominent U.S. cities have experienced large population declines in recent decades. St. Louis, Detroit, Cleveland, and Pittsburgh, for example, each lost half or more of their populations between 1950 and 2010. Others, such as Baltimore, Chicago, and Minneapolis suffered smaller, though still substantial, population losses during the same period. If these changes merely reflected shifts in population from one city to another more desirable or more productive city, there wouldn’t necessarily be any cause for concern. However, evidence suggests that urban population outflows have hurt some lower-in- come people who have been left behind. Declining city centers frequently exhibit high and persistent poverty rates. For instance, in Detroit and Cleveland, 40.3 percent and 36.2 percent of the population, respectively, were below the poverty line in 2015. Meanwhile, the average income of the surrounding suburbs has risen.4 In fact, the met- ropolitan statistical areas (MSAs) surrounding many declining cities have grown in pop- ulation since 1950. For example, the Detroit and Baltimore MSAs each added more than one million people between 1950 and 2010.5 As city centers decline, those people and firms who can leave do, and those who cannot (frequently low-income, low-skilled house- holds) are stuck with dimming economic prospects. Urban policymakers in declining cities justifiably want to revitalize their cities and help the people who live there. To do so effectively, it is important to first understand what fac- tors determine where people and firms locate, both within and across cities, and what might cause them to move. Second, it is important to understand what policies will be effective at reversing urban decline. The economic benefits that arise from people and firms living Federal Reserve Bank of Richmond l 2016 ANNUAL REPORT 5 Chicago generally is an and working together in a city (referred to by economists as agglomeration economies) sug- exception to the rule that gest that even small-scale policy interventions could have outsized effects and potentially wealthier residents prefer to improve the welfare of many individuals living in a city, not just the original target group. But live outside city centers. as this essay will show, policymakers must carefully consider which interventions will best assist the households they wish to help. The mixed record of any one type of urban revital- ization policy suggests that a combination of “place-based” policies (which direct resources to help certain low-income areas) and “people-based” policies (which provide assistance to people regardless of where they live) may be more successful. This essay reviews evidence of the effectiveness of each approach. Why Do Cities Exist? In order to examine the effects of different urban policies, it is useful to first understand the benefits that cities provide. Cities arise because there are advantages to concentrating eco- nomic activity in one place, known as agglomeration economies. When businesses in the same industry cluster together, they can share inputs, such as tires for cars. The more carmak- ers that cluster in a region, the more demand they’ll generate for tires in that region, making it more attractive for tire makers to locate in the city as well. That agglomeration reduces costs for all the carmakers. Clustered firms in the same industry also can share a common pool of skilled labor. For example, the high concentration of tech companies in Silicon Valley attracts a lot of software engineers. This is particularly advantageous in the case of industries where any individual firm may experience sudden changes in demand. Workers can transi- tion from shrinking firms to growing ones as demand fluctuates. Finally, firms may benefit from knowledge spillovers. Discovery of new ideas is facilitated by more people living and working in close proximity, and new ideas spread from firms through shared labor pools and supply chains.6 6 Federal Reserve Bank of Richmond l 2016 ANNUAL REPORT The preceding examples describe localization economies—benefits that accrue from At the most basic clusters of firms in the same industry. But agglomeration benefits also arise from concen- level, households trations of different industries. A variety of firms can take advantage of general inputs such as transportation networks or banking and legal services. Many firms employ workers with face a trade-off similar skills, even if they are not in the same industry, and cities provide access to a larger between land and pool of skilled labor. Firms also enjoy knowledge spillovers from businesses in different fields or from other institutions such as universities. These benefits that arise as a result of a diverse transportation costs. city are known as urbanization economies. Cities also provide a variety of production and consumption benefits to individuals who live there. One striking observation is that all else being equal, it appears that worker pro- ductivity and average wages are higher in more densely populated areas.7 Economists think these gains come from the fact that the larger the city, the more opportunities workers have to interact with other skilled workers and gain valuable experience that they carry with them throughout their careers.8 Concentrations of people also make a variety of amenities, such as restaurants or theaters, commercially viable. Of course, there are limits and costs to urbanization. Higher population densities come with higher cost of land (rents) as well as more congestion and crime. At some point, these costs will discourage further development. What Do Cities Look Like? Agglomeration economies also affect where firms and households locate within a city. When there are benefits from locating close to each other, a variety of different spatial configura- tions can arise. In other words, agglomeration economies can lead to “multiple equilibria.” This provides insight into why we observe the variety of outcomes across cities that we do. For instance, suppose that firms must decide where to set up their facilities in a context in which they benefit from interacting with each other. These benefits, however, decline with distance. This leads to a city with a central business district (CBD) surrounded by a residential area. Simultaneously, some workers may either decide to live close to work, making the CBD a mixed-use commercial/residential area, or live in the suburbs in an entirely residential area. At the most basic level, households face a trade-off between land and transportation costs. Living and working in the CBD lowers commuting costs, but at the same time, housing will be more expensive if many people want to live there. Some households might choose to reside in locations that are more distant from the CBD if they are compensated by lower housing prices. In addition to the value of land, housing prices also reflect factors such as the quality of schools, access to parks, crime rates, and levels of environmental quality that make some locations within the city more or less attractive than others. For example, studies show that people are willing to pay more to live in neighborhoods with good schools. Housing prices rise approximately 1 percent to 2 percent when test scores, used to measure school quality, increase by 5 percent. In dollar terms, this amounts to an increase of roughly $4,000 on average.9 In most U.S. cities, wealthier households tend to live farther away from the city center, though there are a few notable exceptions (such as Chicago, Philadelphia, and Washington, D.C.).10 One explanation for this is that wealthier households prefer to occupy more land and Federal Reserve Bank of Richmond l 2016 ANNUAL REPORT 7 The main underlying therefore are willing to live in the suburbs despite higher commuting costs because the price of housing per square foot is lower. On the other hand, when a household’s income becomes assumption in sufficiently large, it may choose to move back to the city center to reduce time spent commut- these models is that ing. This type of trade-off could explain, for instance, why both very poor and very wealthy households are found living in some downtowns. Cities such as Boston, New Orleans, Atlanta, residents can move and Philadelphia are examples of this type of spatial pattern.